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Answer: The price of the underlying asset is strongly negatively correlated with interest rates.
C is correct. When an asset is strongly negatively correlated with interest rates, futures prices will tend to be slightly lower than forward prices. When the underlying asset increases in price, the immediate gain arising from the daily futures settlement will tend to be invested at a lower than average rate of interest due to the negative correlation. In this case, futures would sell for slightly less than forward contracts, which are not affected by interest rate movements in the same manner since forward contracts do not have a daily settlement feature.
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When comparing the prices of a futures contract bought through an exchange and a forward contract negotiated directly with a counterparty, assuming both contracts have identical maturity and delivery terms, the futures price tends to be lower than the forward price, given no arbitrage opportunities are present. What single factor, if examined in isolation, could effectively explain this observed price difference, especially in the context of anticipated rising interest rates?
A
The futures contract is less liquid than the forward contract.
B
A futures contract offers more flexible terms than a forward contract.
C
The price of the underlying asset is strongly negatively correlated with interest rates.
D
The upfront transaction cost on the futures contract is higher than that on the forward contract.